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Puttnam’s Law

Neal Gabler had an excellent piece in Sunday’s Los Angeles Times in which he outlined “Puttnam’s Law,” named after David Puttnam, the British film producer who lasted only a year as head of production at Columbia Pictures, during which time he refused to push the typical big-budget garbage so often provided by Hollywood and, instead, green-lighted a number of smaller budget “quality offerings” (the kind of movies he had made, such as Chariots of Fire). His idea was that no single movie of that size could bankrupt the studio and that a few hits could greatly enrich it. Unfortunately, Puttnam so threatened the Hollywood status quo that before a single film from his slate was even released, he was unceremoniously forced out of the studio.

So what is Puttnam’s Law? It is more acceptable to fail in conventional ways than in unconventional ways. Its corollary is this: The reward for succeeding in unconventional ways is less than the risk of failing in unconventional ways. In short, you can screw up with impunity so long as you screw up like everybody else.

As Gabler points out, Puttnam’s Law “is not only the iron law of the entertainment industry. It is the iron law of life. No one wants to be caught out on a limb for fear of having it sawed off behind him. Or put another way, there is safety in numbers even if there isn’t necessarily wisdom. When Matthew Weiner wrote his Mad Men pilot and then went around pitching it, he was told repeatedly that it was unsalable because it was set in period and because its protagonist was unhappy and flawed, which is to say, it was unsalable because it wasn’t like anything else on television.”

None of this is news, of course. As Tocqueville remarked early in the 19th century, “I know of no country in which there is so little independence of mind and real freedom of discussion as in America.”

The money management business is no different. The vast majority of money managers and actively managed mutual funds are closet indexes with no realistic chance of outperformance over time because of significantly higher fees. For these managers and funds, performance close to their benchmarks is the objective. The benefits of significant outperformance over time aren’t worth the risks of significant underperformance. Performance near the benchmark keeps clients from complaining too much and keeps assets in place. Career risk is minimized.

On the other hand, real active management, like any truly creative endeavor, is risky. As Gabler emphasizes:

Most people prefer self-protection to the risk of being ostracized. As a result, we increasingly live in retreat from anything that is daring, exciting or different because what would the other kids think if we didn’t all do what they were doing? So there is a monotony in American mainstream culture, an overwhelming sense of groupthink, for which there is no punishment save the awful damage it wreaks on our national imagination and on our sense of creative adventure.

And that’s Puttnam’s Law.

To be fair, our failures in this regard cannot simply be chalked up to risk aversion (the fact that we feel a loss two-to-two-and-a-half times more strongly than a similar gain) and general gutlessness. Innovation is a difficult and messy process (as The New York Times Magazinedemonstrated yesterday) with no guaranteed success. The light bulb had been around for 80 years before Edison found a way to make one that people would buy, but it took another 40 years (and the invention of lots of other cool stuff) before its usage was commonplace. Indeed, even winning investment strategies will have periods — often significant periods — of underperformance. That’s when Puttnam’s Law will really hurt.

It won’t be easy. But if we are really going to achieve something good, for our clients and for ourselves, we’re going to have to defy Puttnam’s Law. No pain, no gain.